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Cablegate: Mexico's Calderon Unveils Tax Reform Proposal

VZCZCXRO2373
PP RUEHCD RUEHGD RUEHHO RUEHMC RUEHNG RUEHNL RUEHRD RUEHRS RUEHTM
DE RUEHME #3246/01 1722030
ZNR UUUUU ZZH
P 212030Z JUN 07
FM AMEMBASSY MEXICO
TO RUEHC/SECSTATE WASHDC PRIORITY 7585
INFO RUEHXC/ALL US CONSULATES IN MEXICO COLLECTIVE
RHEHNSC/NSC WASHDC
RHMFIUU/CDR USSOUTHCOM MIAMI FL
RHMFIUU/CDR USNORTHCOM
RUEHC/DEPT OF LABOR WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 03 MEXICO 003246

SIPDIS

SENSITIVE
SIPDIS

STATE FOR A/S SHANNON
STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH
STATE FOR EB/ESC MCMANUS AND IZZO
USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD
USDOC FOR ITS/TD/ENERGY DIVISION
TREASURY FOR IA (ALICE FAIBISHENKO)
DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD
NSC FOR RICHARD MILES, DAN FISK
STATE PASS TO USTR (EISSENSTAT/MELLE)
STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA)

E.O. 12958: N/A
TAGS: ECON ELAB EFIN PINR PGOV MX
SUBJECT: MEXICO'S CALDERON UNVEILS TAX REFORM PROPOSAL

REF: MEXICO 2518

------------------------
Summary and Introduction
------------------------

1. (SBU) On June 20, President Felipe Calderon submitted to
the Congress Permanent Standing Commission a fiscal reform
proposal that focuses on boosting government revenues and
combating tax evasion. The initiative aims to increase
federal tax collection by 1.9 percent of GDP and state
collection by 0.9 percent -- bringing the non-oil tax intake
from 10 percent of GDP to about 13 percent by 2012. The
proposal includes a new alternative minimum tax designed to
close loopholes companies use to reduce their tax payments, a
2 percent levy on monthly cash bank deposits of more than
20,000 pesos (USD 1,835), and measures to fight tax evasion.
The proposal does not levy food and medicine or cut back on
generous special tax regimes. The process of building
consensus for this proposal will be more difficult than it
was for pension reform. President Felipe Calderon needs
support from opposition parties in Congress, notably the PRI,
to secure the reform's passage. Private sector organizations
have already expressed concern that the new alternative
minimum tax could impede job creation. Calderon has a strong
chance of passing fiscal reform, though the proposal sent to
Congress is likely to be modified. Although Calderon's tax
reform proposal is an important step forward for Mexico, it
is not as comprehensive or bold as many would have liked
given that Mexico has the second worst tax collection rate in
Latin America after Guatemala. End Summary.

-------------------------
The Government's Proposal
-------------------------

2. (U) The Calderon government's fiscal reform proposal
centers on a new alternative minimum tax (called the CETU)
designed to prevent companies from using deductions and
loopholes to significantly reduce their tax payments. This
tax replaces the 1.25 percent tax on assets, and would
require companies to pay the higher of the CETU and the
current corporate tax of 28 percent. The CETU rate will be
16 percent in 2008 and 19 percent starting in 2009, but the
new system reduces the number of deductions. Importantly,
companies would not be allowed to deduct the cost of labor
from income, meaning that more labor-intensive operations may
see their tax bill increase. Business groups have already
been vocal in opposition to this particular change, arguing
that it will hurt job creation. A government press release
says the tax will not harm employment since it is being
complemented by an employment credit. Since the tax allows
for deducting investments, it should help foster competition
and development. The CETU aims to generate additional income
equivalent to 1.8 percent of GDP.

3. (SBU) The reform seeks to impose taxes on the informal
economy in an indirect manner. It introduces a 2 percent tax
that would be assessed on cash bank deposits that exceed
20,000 pesos (USD 1,835) in one month. Individuals and
companies would be able to credit the outlays for this tax
against income taxes. Banks will be responsible for
collecting the tax, taking into consideration the various
accounts opened by an individual. The levy will not be
imposed on diplomatic or consular agents or NGOs. While this
measure will not significantly increase government revenues,
it will help reduce tax evasion. Some analysts have
expressed concern that the initiative will discourage workers
in the informal economy from using banking services.

4. (U) The reform obliges taxpayers to report any loan,
donation, or an increase in capital of more than 600,000
pesos (USD 55,000). To simplify the payment of the income
tax for individuals and professional activities, the salary

MEXICO 00003246 002 OF 003


credit will be eliminated and replaced by an employment
subsidy, which will benefit those with lower income (less
than 7,000 pesos/USD 640 per month). The size of the subsidy
depends on the individual's salary.

5. (U) The proposal introduces a 20 percent tax on lotteries
and gambling-related income, and a 50 percent tax on aerosol
paints. In an effort to improve tax collection at the local
level, it gives state and local governments the authority to
levy products that are subject to the federal Special Tax on
Production and Services (IEPS). This includes such products
as gasoline, tobacco, and alcohol. The application of these
taxes is subject to the approval of local legislatures.

6. (U) The reform also gives the Tax Administration Service
(SAT) more teeth to fight tax evasion. The proposal would
allow SAT to examine the operations of people who deposit
more than 1 million pesos (USD 91,700) in their accounts in a
year but have not accounted for the corresponding tax
payments. It establishes that individuals and companies must
present documentation that SAT requests during an audit.
Currently, many wait until they are taken to court to produce
this paperwork. It also proposes making senior managers of
companies responsible if they omit information during an
audit.

7. (U) The government's proposal leaves the basic income tax
rate at 28 percent for companies and individuals, and does
not attempt to levy food and medicine. Tax exemptions and
special treatments for the agricultural sector remain
unchanged.

---------------------------------------------
Proposal Likely To See Markups Before Passage
---------------------------------------------

8. (SBU) The process of building consensus for this proposal
is likely to prove more difficult than it was with pension
reform. Calderon needs support from opposition parties in
Congress, notably the PRI, to secure the reform's passage.
Private sector organizations have already expressed concern
that the CETU could impede job creation, and some pundits
have pushed for a better way to accomplish the same fiscal
objectives. Calderon has a strong chance of passing fiscal
reform, though the proposal sent to Congress is likely to be
modified. The government would like the reform to be
approved during an extraordinary session of Congress this
summer so the new measures can be incorporated into the
President's 2008 federal budget proposal, which is due to the
Chamber of Deputies on September 8.

-------
Comment
-------

9. (SBU) Calderon's tax reform proposal is an important step
forward for Mexico, but it is not as comprehensive or bold as
many would have liked. It was designed to be both
economically sound and politically feasible, but the latter
seems to have prevented the government from addressing a
number of key issues. The proposal fails to simplify the tax
system in a meaningful way or get rid of many generous
special tax regimes, measures the government had previously
identified as key components of a fiscal reform. The
measures to improve tax administration are helpful, but could
have gone further. Moreover, the reform does not address the
transparency and efficiency of spending at the local level.
As expected, the reform does not attempt to tax food and
medicine or solve the state energy company's fiscal woes.
Further tax reform will be needed to provide the government
the steady flow of revenue it needs to address poverty and
other growing social needs, and to avoid a potential fiscal
crisis down the road due to declining oil production. End
Comment.

MEXICO 00003246 003 OF 003


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